Answer: Example below is gives a better explanation
Parent Company has recently just begun operation and, thus, has a simple financial structure. Mr. Parent, the sole owner of Parent Company, injects $20M cash into his business. This appears as the following journal entry.
Dr. Cash 20,000,000
Cr. Shareholder’s Equity 20,000,000
As such, Parent Company’s balances are now 20M in assets and 20M in equity.
The next month, Parent Company sets up Child Inc, a new subsidiary. Parent Company invests $10M in the company for 100% of its equity. On Parent’s books, this shows up as the following.
Dr. Investments in Subsidiary 10,000,000
Cr. Cash 10,000,000
Parent Company now has $10M less cash, but still has a total of $20M in assets.
On Child’s books, the same transaction would show up as follows.
Dr. Cash 10,000,000
Cr. Shareholder’s Equity 10,000,000
At the end of the year, Parent Company must create a consolidated statement for itself and Child Inc. Assuming no other transactions occur in the year, the consolidated statement would look like the following:
Parent Company Child Inc. Elimination Adjustment Consolidated
Assets
Cash 10,000,000 10,000,000 20,000,000
Investment in Subsidiary 10,000,000 -10,000,000 0
Equity
Shareholder's Equity 20,000,000 10,000,000 -10,000,000 20,000,000
As can be seen above, the elimination adjustment is necessary so as not to overstate the consolidated balance sheet. If the elimination adjustment were not made, the consolidated assets of both companies would total 30,000,000, which is not true, as money was simply moved between the two companies. In other words, not making the elimination adjustment would result in a false creation of value.
Explanation:
